LMA responds to the ECB and the Bank of England ("the Central Banks") consultation for a better functioning securitisation market07 July 2014
The LMA has responded to a discussion paper issued by the Central Banks on the case for a better functioning securitisation market in the European Union.
We have provided the Central Banks with our specific recommendations as to what could be done to improve securitisations in the context of CLOs, as well as general feedback relating to the CLO market generally.
Key points arising as part of the LMA's response include:
1. Open market managed CLOs do not fit easily within the definition of securitisation, resulting in unintended and disproportionate negative consequences for the industry
The LMA has stressed that open market managed CLO portfolios have an uneasy fit within the definition of securitisation used in the Capital Requirements Directive ("CRR") and other regulations. For example, they do not have a single originator who is involved in the transaction. There is no significant risk transfer. The sponsor (being the CLO manager) did not (prior to the retention rules) take significant exposure to credit risk. The assets are not static, and whilst clearly they provide the cash flows which provide the payments on the notes, the structure of the transaction is equally important to the CLO's risk profile. As such new securitisation regulation frequently impacts CLOs in ways which are possibly unintended, and are certainly negatively disproportionate when compared with actual default rates.
2. The impact of regulation on the CLO market has resulted in a reduction of loan market liquidity
As a result of the various regulatory constraints impacting managers involved in CLO transactions and the uneasy fit of CLOs within the securitisation regulatory framework, the industry has encountered significant problems in ensuring compliance. Consequently, this has resulted in a restriction on the number of CLO managers who can bring deals to market, thereby reducing investor choice. Additionally, larger managers are restricted as to the number of deals they can complete, due to the size of the retention requirements they are required to hold as sponsor.
3. A well-functioning CLO market is necessary in order to inject much needed credit into the loan markets
The LMA agrees with the Central Banks that there are numerous benefits to a well-functioning securitisation market. However, it has also stressed that the CLO market has its own unique benefits as a source of liquidity. The LMA has stressed that, as the well-publicised €122 billion "refinancing wall" approaches, there is a significant risk that many European corporate borrowers will be unable to refinance their existing debt via traditional methods, such as through relationship banks. Whilst the high yield bond market or the IPO market can fill a portion of this refinancing gap, many borrowers will be unable to access these markets for a number of reasons, such as their enterprise value, size or credit profile. Therefore, as European corporate refinancing requirements substantially increase, there is a concurrent risk of refinancing options and investment capacity substantially diminishing. If regulatory restraints on the CLO industry could be made less onerous, it is likely that this would result in a much needed liquidity injection into the European economy.
Nicholas Voisey, Director, LMA, commented:
"Whilst it is encouraging to see the Central Banks considering the benefits of the securitisation market in Europe, from the point of view of CLOs, much could still be done to restore this valuable source of liquidity to the corporate loan markets."
"The LMA would support any Central Bank initiative to create a better-functioning securitisation market, but would stress that the treatment of CLOs would better be considered in isolation, with proper and proportionate regard being given to their risk-mitigating structural features and low rates of default".